Welcome to the multipolar world

Decades of economic change, financial crisis and political upheaval are bringing an end to the 'Davos age' of globalisation

by Meghnad Desai

Sat 18 Aug 2018

Memories are short. Many people forget that the ubiquitous liberal free trade order is only around 25 years old. We can date its start to the aftermath of the fall of the Berlin wall and the break-up of the Soviet Union. The European Union's single market started in 1993; the World Trade Organisation was set up in 1995.

What is in no doubt is that the (re)birth of a multipolar world is a reality. In a three-part series, I look at the US and Chinese roles in catalysing this transformation, the implications for different economies around the globe, why most of the changes we are witnessing were predictable, and why we should not necessarily fear them.

US President Donald Trump plays a big part in this. The liberal free trade system he is seeking to redefine was never as liberal as its champions claim, but it has defined the global order. The other pivot has been the military umbrella the US provides through the North Atlantic Treaty Organisation, formed in 1949, which Trump now appears to wish to dismantle.

The end of the 1945-1991 cold war and the WTO's genesis made commentators call the 1990s 'the end of history'. Western political and economic systems allegedly represented the conclusion of humanity's sociocultural evolution, with the US as the sole superpower. It was never as simple as that. Many in the liberal order wished for a multipolar world. And this is what they have now got.

There are some piquant ironies here. When Chinese President Xi Jinping asserted his support for globalisation and free trade at the January 2017 Davos World Economic Forum, many European leaders hailed the rebuff to Trump's assault on the modern liberal order.

China was championing free trade while not fulfilling the WTO's conditions for qualification as a free market economy. China's state subsidies are opaque. It blocks market access to outside investors, and it has a dubious record on protecting intellectual property rights. The EU, for its part, is a customs union that, by definition, does not practise free trade but is a protectionist agreement. Only the US is a practitioner of free trade, except in the case of farm products, where all countries are sinners.

Trump says the US can no longer afford to be the generous provider of such global public goods as Nato, the world trading system, and international sea lanes policed by the US navy.

In 1945, most economies were shattered after a decade of depression and then six years of world war. Most economies had been using tariffs and quotas to trade with each other, with Britain a relatively liberal outlier. The US led the postwar reconstruction of free trade, abandoning its high tariff policy of the previous 100 years and introducing a series of mutual tariff cuts under the 1947 General Agreement on Tariffs and Trade, with the Kennedy round in 1964 and Tokyo round in 1973 being the larger ones. These were mainly between developed countries. The Uruguay round, which began in 1986, included emerging markets as active participants, foreshadowing the WTO's 1995 establishment.

In the beginning, protectionism was allowed for developing nations, just as European countries were permitted a common market and customs union, a major departure from free trade. With the signing of WTO, all were on the same level regarding permissible domestic trade policies. But, between 1945 and the mid-1990s, the shape of the global economy had changed.

During the cold war the US and Soviet Union competed on many fronts without engaging in direct conflict. The US fought a long proxy war against communism in Northeast Asia during the Korean war and later in Southeast Asia. Despite suffering major losses in both territories, the US repelled the challenge, driving the Soviet Union into dissolution.

But this was only part of the reshaping of the global economy. The US abandoned the gold-dollar link in 1971. Oil prices quadrupled in 1973. Innovations in satellite communications and shipping made it economical for manufacturing industries to shift from high-wage developed countries to Asia's low-wage economies. Advanced economies moved up the value chain with successful high-tech and service sectors, especially financial services. Emerging economies in Asia began to industrialise rapidly and demanded access to developed economy markets during the 1986 Uruguay round – an attractive proposition for western companies. Consumers in developed economies benefited from lower manufacturing prices. The US accrued huge trade deficits as the world invested its savings in US Treasury securities.

Thus began the 'Davos age' of globalisation. However, along the way the manufacturing labour force in developed economies had shrunk, and the wages of low-skilled workers had stagnated. The financial sector made borrowing easier with subprime mortgages and similar innovations. For a while between 1995-2008, everyone was happy. But it couldn't last. And it didn't.

How fault lines became clear

When the 2008 financial crisis came, few thought the ensuing recession would have such long-lasting consequences. But 10 years later, the fault lines previously hidden in the economic structure have become clear. Every trading regime has gainers and losers. To maximise social welfare, those who gain from the benefits of free trade are expected to compensate those who suffer losses. Of course, no one is actually compensated; the losers simply adjust to their losing positions.

The crisis made this adjustment difficult, especially in the US. Detroit's fortunes illustrate the shift. The hollowing out of the manufacturing sector had altered the geography of US prosperity, which moved to the coasts while leaving behind the middle of the country that had thrived in 1945-75. The same happened in the UK, with the decline of England's industrial north east, Scotland's shipyards and Wales' coal mines.

Different countries have felt the political effects at differing paces. The collapse of Italy's established parties occurred 15 years before the same fate befell French politics in the 2017 presidential elections. In Germany, the success of Alternative for Germany in 2017 marked the first time since the 1950s that a radical right-wing party achieved a mainstream parliamentary presence. The UK faced the rising popularity of the UK Independence Party, a contributing factor to the 2016 referendum on leaving the EU.

Trump is the first right-wing political leader to propose a complete review of the modern liberal order, focusing on trade. The WTO promotes the idea of the world trading system as forging a common interest for trading nations on an equal and symmetrical basis. Any rules-based system in which members are unequal in strength and size will not live up to the ideals behind it. This has been the case for the WTO. We see the consequences in Trump's desire to reshape the multilateral trading system into a series of bilateral relationship with nations that run a trade surplus with the US; Russia does not appear on this list.

Likewise, in disassembling the Nato, Trump wishes to negotiate bilateral relationships with the powers he believes matter most to US security – Europe does not matter in this set.

In Trump's US-centric view of the world trading system, measuring countries' importance by the size of the US trade deficit, China tops the list. Next is the EU, then the partners in the North American Free Trade Agreement. Instead of a universal set of rules applicable to all, Trump wants individual bilateral agreements with each large trading partner. He rejects multi-country, multi-product regional accords such as the Trans-Pacific Partnership.

The world Trump wants trades bilaterally, with dozens if not hundreds of bilateral treaties regulating trade relations between pairs of nations.

This is not entirely fanciful. Rather, it represents the world as it was before 1945, when there were no agreed rules on international trade. Each imperial country had its own rules for trade within its empire. Trade between Europe's imperial powers was not always friction-free. Independent nations like the US developed informal regional trading blocs. It was a miscellaneous arrangement. The system Trump wants to build may retain elements of the modern liberal order, particularly in the form of blocs like the Association of Southeast Asian Nations, but the big players will behave like the pre-1945 imperial countries.

Trump's vision for geopolitical relations is similarly bilateral. He notes that the cold war ended with US victory, with Europe prospering in the decades since, in his view, at Washington's expense. His main concern in Israel and the Middle East. This is why he has focused on Iran as the enemy and Saudi Arabia as an ally. Becoming more involved in the Korean peninsula is a way for Trump to put pressure on China. He is not interested in Nato and other multilateral forums like the G7 and G20, and the United Nations is a low priority.

Many countries may not like what they see in Trump's world view. But the precursors have been rather evident for many years. Adjusting to the new state of affairs may not be as difficult as many believe.

Trumpian upsets: who's up and who's down

Many commentators are alarmed that Trump's trade actions will impose huge costs on the world economy. The direct effect of tariffs is to raise the cost of goods as trade wars escalate. The total volume of trade may fall, with more expensive domestic products substituting for cheaper foreign-made goods. This would boost employment in countries that have hitherto relied on imports, and it would increase inflation – meeting the current needs of central bankers in most advanced economies.

That, at least, would be the effect for final products. Analysts are more anxious about trade in intermediate input products, which are crucial to the geographically dispersed production systems that arose in the 1970s. Before then, production systems were mainly domestic and vertical integration was much prized.

The disruption of production with international supply chains is the most worrisome possible outcome of Trump's actions. But, as always, constraints will promote innovation. After all, the system that arose in the 1970s was concocted by Japan to overcome its shortage of raw materials. Tokyo concluded that the country did not need to own coal mines or iron ore deposits to produce steel, as these materials could be imported. While US steel was vertically integrated, Japan had flat structures.

In the light of advances in technologies such as 3D printing and artificial intelligence, it is not far-fetched to imagine that businesses could manufacture domestically the intermediate products that they currently import. International trade would continue, but the product mix would shift from intermediate to final products.

Trump's handling of North Korea shows that, through his bluster, his goal is accommodation with an irksome country. He has shown the same approach with Iran, making threats first and offering talks later. He wants a bilateral deal with Tehran, regardless of what the EU or Russia may think. With Moscow, he wants a bilateral relationship void of belligerence. If Europe's leaders have a problem with Russia, they should address it themselves.

We should not fear Trump's post-Davos world. It simply represents the next phase of capitalism after the liberal trading order that started in 1995. With a plethora of interested parties, rather than just two competing superpowers, there will be winners and losers. The Trump alternative favours larger continental economies that can develop domestic production systems with imports of raw materials but few intermediate products needed for 'just in time' inventory. In this category we could include regional trade groupings such as the Association of Southeast Asian Nations and the EU. India will benefit as it has an autarky mindset.

Further free flows of capital (and Trump has not been worried about that), will facilitate trade. As it is, the developed economies have outsourced supply of standard manufactured goods to Asia. Trump may encourage Asian countries to move up the value chain and become more industrialised. For the developed economies, services would become an even larger focus as they are not the topic of tariff retaliation as of now. The West can sell its expertise in high-tech industrial production to Asia rather than manufacture at home. Activities such as artificial intelligence and fintech innovation will grow rapidly as the trade environment becomes challenging. These can also be exported by the developed economies to Asia.

The redesigned geopolitical order is trickier to assess. The end of the cold war almost 30 years ago has made the Nato obsolete. Most conflicts involving the US in the last 25 years, mainly in the Middle East, have been fought with minimal if any help from its Nato partners, with the exception of the UK. The free-riding European members do not think of security as their concern; they believe the US will take care of it.

European countries (apart from the Visegrad states, namely the Czech Republic, Slovakia, Poland and Hungary) have failed to spend money on their own security. They couldn't tackle the Yugoslavia crisis without US help. The UK and France mishandled Libya, and the US refused to bail them out. Europe's defence challenges may not come so much from Russia as from the Mediterranean and the Middle East. The EU has been under the delusion of living in a post-Kantian world of universal peace. It will now have to spend serious money on defence. It will also need a formal security pact with the UK after Brexit. The only European countries that may still need to rely on US protection are the Baltic states. The rest of Europe will have to grow up and defend itself.

The US will pursue a variety of bilateral relationships in trade and security. It will no longer explicitly lead the world, nor pay for global public goods. The rest can go about their trade and security as they please, striking deals and coming to arrangements as befits national purposes and preferences.

The much-desired multipolar world is here. This does not herald the return of anarchy. The world system of the past quarter-century was never as faultless as often advertised. We should get on with making the best of circumstances which are neither as new nor as troublesome as many imagine.

Lord (Meghnad) Desai is Emeritus Professor of Economics at the London School of Economics and Political Science, and Chair of the OMFIF Advisers Council.

Desai was among the relatively few international political commentators taking Trump seriously before the November 2016 presidential election. Download Desai's July 2016 report on Trump's political economy, as well as his April 2017 OMFIF book on the president's first 100 days in office.